U.S. Securities and Exchange Commission launches Share Class Selection Disclosure Initiative

The Division of Enforcement seeks self-reporting from registered investment advisers (RIAs) and prompt return of investor funds. 

The Investment Advisers Act of 1940 imposes a fiduciary duty to act in their clients’ best interests and an affirmative duty to disclose all conflicts of interest. Under the Share Class Selection Disclosure Initiative (SCDI), the SEC’s Division of Enforcement (Enforcement) will not recommend financial penalties against those advisers who self-report violations of the federal securities laws relating to improper mutual fund share class selection if money is promptly returned to harmed clients.

Here are the top five things to be aware of:

1. Nature of the problem

Advisers failed to disclose conflicts of interest in receipt of 12b-1 fees by either the adviser, its affiliates or supervised persons when a lower cost mutual fund share class was available (i.e., one with a lower or no 12b-1 fees).

2. Mechanics of disclosure 

Advisers to be eligible must notify Enforcement their intent to self-report by email or the U.S. Postal Service on or before June 12, 2018. Thereafter, within 10 business days, the adviser must submit a related completed questionnaire.

3. Recommended settlement terms        

Eligible misconduct can go back to Jan. 1, 2014. Eligible settlements will include recommendations of a cease and desist and neither “admitting nor denying” the findings. Furthermore, a censure will be recommended against eligible parties.

4. Undertakings

Whether it was done voluntarily or by order from Enforcement, the eligible RIA must:

• Review, and if necessary, correct relevant disclosure documents like Form ADV Part 2A and/or 2B;
• determine whether existing RIA clients should be moved to a lower cost mutual fund share class and make such changes, if appropriate;
• notify all affected clients of the settlement terms in a conspicuous and clear fashion; and
• determine the effectiveness, if applicable, of policies and procedures to ensure that they are “reasonably designed” to prevent violations of the Investment Advisers Act in connection with the RIA’s disclosures regarding mutual fund share class selection, and provide Enforcement, no later than 10 calendar days after certificate regarding compliance with the RIA’s undertaking.                                                                              

5. The fine print

While Enforcement will not recommend financial penalties (i.e., civil monetary penalties), that does not include disgorgement of wrongly earned fees, which will be required, plus pre-judgment interest on that amount at the applicable rate. The respondent will pay this disgorgement to “affected clients.” Those include current and former clients of the RIAs or their affiliates or associated persons.                   

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: Andrew S. May, Principal